Economic Update | Upbeat on Manufacturing

By Dr. Uric Dufrene, Sanders Chair in Business and Professor of Finance, Indiana University Southeast

Indiana has long been a heavy manufacturing state.  Despite overall declines in manufacturing employment, Indiana continues to rank in the top ten nationwide.    Hence, the outlook for national manufacturing is an important economic indicator for both Indiana and locally here in Southern Indiana.   Despite recent declines in the ISM Manufacturing Index (pointing to a deceleration in manufacturing growth), the outlook for Southern Indiana manufacturing remains upbeat.   First, we’ll look at where we’ve been, what we can expect this year, and trends shaping up beyond.

Since the first quarter of 2020, manufacturing employment across the five counties of Southern Indiana remains in a deficit of approximately 1,200.  Overall payrolls are down about the same, approximately 1,150.    On the wage front, we observed a significant increase in hourly average wages during the first year of the pandemic, reaching a historical high in the 4th quarter of 2020 as employers scrambled to find labor to meet demand.

Manufacturing was hit from both sides:  demand and supply.  On the demand side, we observed perhaps one of the largest, if not the largest, increase in goods expenditures.      Early in the pandemic, capacity utilization rates plummeted due to shutdowns and the overall slowdown of the economy.   At the same time, demand was about to skyrocket.     As demand began to escalate, manufacturers were also faced with labor challenges and materials shortages.   This simply compounded the problems associated with meeting demand.

Significant increases in demand also became a challenge for the nation’s supply chain.   Using a simple example, if the supply chain has the capacity to ship 100 boxes of freight, but orders total 1,000, that means 900 boxes will have to wait for the next truck.     We get a clue of this through the number of truck driver postings.  Before the pandemic, at a time when there was already a shortage of truck drivers, nationwide postings stood at about 127,000.   In the last quarter of 2021, nationwide truck driver postings were more than double at 270,000.  Simply speaking, we simply did not have enough trucks, or supply chain capacity, to move the level of goods through the system.

But let’s get back to manufacturing.    Why do I continue to remain upbeat on manufacturing, despite some of the headwinds the economy faces?     One indicator is to look at inventories.   Inventories remain very lean. The ISM Customer Inventory component continues to hover at all-time low levels.   There was some improvement from the record low in July 2021, but levels remain significantly under pre-pandemic territory.   The inventory to sales ratio is also pointing to very lean inventories nationwide.    The last reading of 1.09 is significantly under the 1.43 reading prior to the pandemic.   When we combine both inventory and sales into one convenient inventory to sales ratio, it suggests that the “shelves need significant restocking”.    The previous pre-pandemic low of the inventory to sales ratio was observed back in 2012.    Manufacturing employment across Louisville Metro then followed with the largest percentage gain among all economic sectors.

On the new orders front, we are seeing record high levels.   New orders were higher only once, back in 2014, but quickly receded to trend levels.   Except for that 2014 outlier, new orders are at an all-time high.     Unfilled orders are also running at record highs.

Low inventories and orders combine to form a favorable outlook for manufacturing production this year.   Challenges do remain, however.   Perhaps the biggest is on labor availability.    The nation’s labor force remains about 2.5 million workers under the pre-pandemic level, and the labor force participation rate has been stuck in the 61% range since June 2020.  Manufacturing quits are also among the highest (not the highest, but in the top 5), totaling 293,000 as of November 2021.   This compares to a quits level of 189,000 before the pandemic.

The last national employment report indicated 2.5 million workers were not in the labor force;  1.4 million did not search for work last year, and 1.1 million searched for work.    We should expect some of these workers to re-enter the labor force this year.   Given that labor was scarce before the pandemic, and expected to remain, how will manufacturers meet demand moving forward?    We get a hint by observing investments in software and industrial machinery.     Investments in software and information processing equipment are at record highs, and software expenditures have accelerated the past year in a half.   Investments in industrial machinery, a component of non-defense capital goods are also at all-time highs, and with significant acceleration in the rate of spending the past two years.     It takes time to implement a new production process, but we are likely seeing investments that allow manufacturing to meet greater demand, but perhaps with fewer workers.

Data sources:  STATS Indiana Quarterly Census on Employment and Wages, Burning Glass Technologies,  Census Advance Report Durable Goods, FactSet, Bureau of Labor Statistics Employment Situation Report, ISM Report on Business.

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